Ongoing conflict in Europe and its environs has sparked defense investment, which has in turn generated a wave of new GPs focused on the region’s burgeoning defense-tech market.
Since 2021, there has been a marked activity increase in the sector, with 2024 setting a new record of $531.6 million invested across 16 deals, according to PitchBook data—more than double the amount raised by startups in 2023. This increase in investment has broadly coincided with Russia’s invasion of Ukraine in 2022 and more recently with the Israel-Hamas war.
Alongside the increase in venture capital investments, new firms have set up shop to capitalize on the sector’s significant growth. Ukraine’s D3 Venture Capital launched last year as did Lithuanian VC Scalewolf. Earlier this year, London-based Twin Track Ventures emerged to target dual-use technology startups.
“We are living in an increasingly dangerous world,” said Expeditions Fund co-founder and GP Mikolaj Firlej. “Many are now feeling a sense of urgency and mission to use money and networks to invest in early-stage companies that could move the needle and help protect us.”
Calling in the experts
Tech investors historically shied away from the defense-tech market—not only because of the related ESG risks but also the difficulty in securing government contracts.
However, with the conflict in Ukraine, rising tensions in the Middle East and other geopolitical tensions, national security has become a priority for governments, globally. Dual-use technology—any product or software that can be used for both civilian and military purposes: GPS, for example—has also become more of a focus for startups in the sector.
The minting of unicorns in the defense-tech space has also attracted new investors, according to Firlej. Germany’s Helsing reached unicorn status last year. Now, the German company is worth €4.95 billion (about $5.38 billion), TechCrunch reported.
But while investments are growing, Europe’s defense-tech market is still significantly smaller than in the US, where deal value for this year stands at $2.4 billion, according to PitchBook data. Nicola Sinclair, founder and GP of Twin Track Ventures, believes that emerging managers are the key to unlocking further growth in Europe’s defense-tech sector.
“Emerging managers play a key role [in supporting the growth of defense tech],” Sinclair said. “We usually have a deep understanding of the tech and know the founders. In my view, we are usually better positioned to come in early to a deal that would be overlooked by a bigger, generalist fund.”
Sinclair, who was previously a wing commander with the Royal Air Force, believes that having the benefit of sector expertise at early stages give startups in the defense-tech space a significant advantage.
There is also evidence that domain expertise matters when it comes to the success of portfolio companies. A recent PitchBook analyst note found that startups that have raised funding led by investors with high domain expertise were 1.2x more likely to exit successfully.
“Trust really matters in defense and security. It’s hard to have this without being an insider,” Sinclair said.
Platforms, not pistols
Setting up a new defense-tech fund is not without its challenges, however, not least because the current fundraising environment has been especially difficult for emerging managers.
According to PitchBook’s Q3 2024 European Venture Report, almost two-thirds of capital raised by European VCs this year went to experienced firms—defined as those with four or more funds—their highest percentage in a decade.
But the sector itself can be an obstacle when raising capital, according to Firlej, particularly when VCs must rely on government agencies as the main source of LP commitments.
While attitudes are changing, he said, it’s not happening fast enough. Many LPs still have strict criteria on what they can and cannot invest in even if they are active in the defense sector.
MD One Ventures partner Nicholas Nelson echoed this, saying that far too many LPs have a misconception that defense tech is “just bullets and bombs,” when in reality there are many companies in the sector that look more like SaaS startups than a weapons manufacturers.
This misunderstanding doesn’t just hold back LPs on account of ethical concerns, but also returns. Hardware tends to be much more capital-intensive and requires longer timelines to produce a product than software companies.
GPs focused on dual-use technologies are finding it easier to raise, Nelson said, but it can cause more harm than good.
“In Europe, dual-use is often used to make defense more palatable,” he said. “I think that does [the sector] a disservice as it creates almost a negative demand signal towards defense. It needs to change, and that signaling needs to come from governments and organizations that provide the capital.”
With growing geopolitical instability, Nelson said that VC appetite for defense tech will continue to intensify globally. Add to that the maturation of the US market, and he believes that more investors will be looking to Europe.
“I would say that we’re in a hype cycle for defense tech right now,” Nelson said. “For the top-end deals, we’re going to see valuations being driven up. But I think [in Europe] we’re still very much in the walk phase of the crawl, walk, run methodology. I think that managers with networks and credibility are going be in the best position to grow European defense tech.”
Featured image by Dragos Condrea/Getty Images
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